Advantages & disadvantages of interest rates

Written by walter johnson

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There was a time when the charging of interest on loans was sinful -- it was using one's financial power for the sake of extorting money. After the banking debacles of 2007 to 2008, questions on the morality and usefulness of interest rates have arisen yet again. The banking system operates on the interest rate principle, and therefore, the modern economy is based on interest. This truth, however, does not show how the charging of interest is morally justified.

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Usury

Usury at one time was the charging of any interest whatsoever. Today, it is the charging of excessive interest. The modern concept of interest rates centres around the risk that lenders take in financing a venture. Gary Moore, writing in "The Christian Science Monitor," argues that there is a substantial moral difference between lending for charity and lending for investment. The latter can charge interest commensurate with risk, while the former can morally charge no interest at all. Usury in modern times is the deliberate charging of high interest beyond that which is needed to cover risk.

Profit

Usury in its modern sense is connected to profit. Banks make huge profits through charging interest on loans. Therefore, modern banking charges interest not merely to cover risk or future inflation, but to make money from money. In the Middle Ages, Pope Paul II created a "Poor Man's Bank" that was to loan money without interest to those who needed it. It was a not-for-profit bank that served as a means to rationally distribute charity. The medieval mind held that interest rates were not an intrinsic part of the economy, but that true economics should be based on charitable giving. However, both Jewish and Italian banks in the High Middle Ages dominated Europe because they created the first modern banking systems. It quickly became clear that prosperity was based around a banking system that can share the risk of investment and regulate the distribution of capital revenues.

Modernity

Modern economics is dominated by banks that control both personal and investment capital. Those who defend charging interest on loans hold that these rates regulate the economy in a rational way. They are tools to control inflation, cool down excessively fast growth, they stabilise the economy and reflect the demand and supply of capital. The defence of interest rates centres around the need for a regulatory mechanism that rationally distributes access to capital.

Morality

Usury and interest are really two different concepts. Interest can be morally justified in covering future rates of inflation and in covering risk. It is another matter to use interest to make a profit unless an investment bank was to hold that its market research, professional expertise in investment and economic analysis was the justification for charging interest on its loans. This would not be "interest," literally speaking, but rather a fee for a needed and legitimate service. The distinction between Roman and medieval ideas of interest and modern ideas is that the latter is institutional and heavily involved in market research. The former was the use of a "strong man's" influence to make money from someone else's misfortune.